Swaps ease debt but don't solve problem

Debt-equity swaps have caught the fancy of finance ministers in the third world - and bankers in the first. They are clever ways of taking questionable loans off the books at banks and liquidating small amounts of the massive debt of developing countries. ``But they don't offer a definitive, long-term solution,'' says Javier Murcio, an economist specializing in Latin America with Data Resources Inc. of Lexington, Mass. ``The amount we're talking about is very, very small - a few hundred million dollars in a continent [South America] with billions in debt.''

Latin America's external public-sector debt amounts to more than $370 billion. So far only about $5 billion worth of conversions have occurred.

Still, countries such as Mexico and Chile have found that swaps keep their debt from growing substantially - and they give a morale lift to the debtor nations by at least making it appear that the huge financial burden is being eased. But economists point out that the debt does not vanish. It is transferred from an external debt to an internal one.

In a typical swap, a company buys a third-world loan from a bank at a deep discount. The company then swaps this dollar-denominated IOU with the debtor government for local currency - usually at a favorable rate to the company, provided the money goes to economic development in the country or to buy a state-owned enterprise. The company often must promise that profits will not be taken from the country for five to 10 years.

Part of the third-world country's debt is wiped out, pleasing both the country and the bank. And the company gets an equity stake in the country.

US Treasury Secretary James Baker III and British Chancellor of the Exchequer Nigel Lawson, among others, have endorsed these swaps. Economists generally concur, but with a few reservations.

``Monetary authorities have to be very careful,'' says Dr. Murcio of DRI, ``because these swaps could lead to inflation.''

William Cline of the Institute for International Economics in Washington points out that, besides inflationary overtones, rampant swapping can also substitute for what might be more beneficial direct foreign investment.

The debtor government, moreover, must float new domestic debt - often at interest rates that are much higher than the international debt - in order to ``sterilize'' the swap payment it makes to the local company. In any case, the country pays something, either in taxes, inflation, or lost investment opportunity.

But as long as the swaps are kept under control, a little inflation may be preferable to a groaning debt, notes Brian Hannon of the Office of South America of the United States International Trade Administration.

Banks take the biggest losses, selling loans at a discount. But at least they get something for loans that otherwise might never have been collected.

Bankers do worry, however, that if enough of this debt is ``marked to market,'' accounting rules in the United States will force them to revalue the rest of their loans to reflect the discount at which they are trading. So far, however, the US government has allowed loans to be written off on a cash basis and has not insisted on the marked-to-market provisions.

Mexico, Chile, Argentina, Brazil, and the Philippines are among the leaders in putting swaps together, Mr. Hannon says:

Chile has tied swaps into an ambitious privatization program. Last year, in the biggest Chilean deal to date, Bankers Trust bought a $60 million loan from Manufacturers Hanover and converted it into a 51 percent stake in Chile's largest pension fund, AFP, which was once the nation's social security system but is now private.

Mexico, too, has embraced the concept. Last year, Nissan bought Mexican government debt in the secondary market in New York for 57.5 cents on the dollar. The Mexican Ministry of Finance then bought this obligation from Nissan for 88 cents on the dollar in pesos. Nissan will use the money to increase its capital base through new investment, warehouses, and other facilities.

Brazil, which has been in a showdown with creditors since early this year, strongly backs debt-equity swaps and has indicated it might use suspended interest payments owed to foreign banks to fund them. In early April, Finance Minister Dilson Funaro told US executives in New York that swaps are ``part of a solution.''

The Philippines recently took swaps one step further by packaging newly rescheduled loans for quick sale. As part of a $13.2 billion debt restructuring package in late March, the Philippines unveiled a new financial instrument known as the Philippine Investment Note (PIN). This is a non-interest-bearing, foreign currency obligation of the Central Bank of the Philippines, guaranteed by the government.

PINs may be redeemed at any time prior to maturity (six years) for their full face value in Philippine pesos in order to fund an approved equity investment. Because there are no fees attached to PINs, the government believes they will trade in the secondary market at 5 to 10 percent above the price of Philippine public-sector debt and emphasizes that since this is debt that has already been restructured there is ``no financial disadvantage to the banks.''

Of course, the bank has already made a concession on the interest rate through restructuring.

Swaps, says Mr. Hannon of the International Trade Administration, are ``good complementary efforts, but they're far from solving the problem.''